Thursday Morning Market Snapshot

Morning Market Snapshot:

Stock index futures are higher, with the S&P 500 +0.42%, the Nasdaq 100 +0.75%, and the Dow Jones Industrial Average -0.07%.

The major developments overnight/late yesterday…

Semicap equipment manufacturer Lam Research (LRCX) reported third-quarter earnings of $0.86 compared to the consensus expectation of $0.80 while revenues were $4.17 billion compared to the $4.06 billion estimate. CEO Tim Archer said recent investments in the business leave it well positioned to outperform moving forward. Management endorsed fourth-quarter earnings of $0.87 on $4.3 billion in revenue, based on strong AI demand. Both of these numbers exceeded Wall Street’s estimates, sending Lam Research’s shares are up more than 6% in pre-market trading.

This comes a day after Korean semiconductor manufacturer SK Hynix reported record quarterly operating profit. The Nvidia (NVDA) supplier said it expects high bandwidth memory (used in generative AI chipsets) sales to increase from 30% of DRAM revenue in the third quarter to 40% in the fourth quarter. In addition, it anticipates AI chip demand to drive outperformance next year. These two results point to the disappointing guidance from Dutch semicap equipment manufacturer ASML Holding (ASML) being more of a company specific issue. That should boost sentiment for semiconductor stocks.

On the monetary policy front, there were a number of developments…

European Central Bank officials sounded increasingly concerned about economic growth. While speaking in Washington, D.C., Bank of Portugal Governor Mario Centeno said a 50 basis point rate cut should be on the table at the upcoming monetary policy meeting in December. He noted the economy isn’t growing and downside risks are increasing. He stated inflation growth is dropping faster than policymakers expected.

Noted policy hawks Klaas Knot (Holland), Robert Holzmann (Austria), and Joachim Nagel (Germany) also weighed in. Knot said the ECB needs to pay attention to inflation undershooting its target, suggesting it could keep cutting until interest rates reach the neutral level. Holzmann leaned in the direction of another rate cut in December due to slowing consumption. Nagel was more cautious saying it should remain flexible about policy, but appeared to favor easing.

Chief Economist Philip Lane said recent economic data is raising questions about the potential for a recovery. He said disinflation is making progress, helping to cool price growth. However, he still believes unemployment will remain low and economic growth will rebound as interest rates continue to drop. So, he said the Governing Council shouldn’t commit to a prescribed rate path as a result.

The statements are a noted shift in commentary from ECB policymakers. Heading into the summer, the group was saying it can take its time cutting rates. Now, the conversation is increasingly focused on disinflation and how low borrowing costs can go.

The Bank of Canada cut interest rates by 50 basis points yesterday. This marked the fourth rate cut this year for a total of 125 basis points. It said inflation growth has eased significantly and is expected to remain around the 2% target for the foreseeable future. It also predicts economic growth will slow in the second half of the year before increasing in 2025 and 2026. As a result, Governor Tiff Macklem anticipates it has room to reduce borrowing costs even more.

The Federal Reserve’s Beige Book survey showed economic activity was little changed or declined slightly in 10 of the 12 regional districts since early September. It said employment growth improved slightly, with low turnover and limited layoffs. But a rise in the available pool of workers helped keep a lid on wage gains. Inflation growth moderated as companies said that increasing price sensitivity and consumer purchases shifting toward less expensive alternatives.

The content of the survey is important when it comes to deciding on monetary policy. It’s published eight times a year and is comprised of anecdotal information from businesses across the 12 regional Fed districts. The survey is meant to show changes in economic conditions since the release of the lats report. It’s used by Fed economists and their staff to assess economic conditions and identify trends that doesn’t always show up in economic data. Yesterday’s report indicated activity slowed compared to the September survey.

These results support bond market expectations for even more interest rate cuts over the next 12 months. According to the Chicago Mercantile Exchange’s FedWatch tool, investors now anticipate our central bank will lower the overnight lending rate by 125 basis points between now and July 2025 compared with last week’s expectation for 150 basis points by September 2025.

My perspective on the markets…

Investor expectations for Federal Reserve monetary policy remain dovish. The bond market currently expects the effective federal funds rate will drop to 3.6% by June 2025, compared to the current 4.9%. Policymakers including Chairman Jerome Powell, have said the gradual slowdown in hiring and easing of inflation growth gives them room to normalize interest rates. The shift should underpin even easier monetary policy heading into next year.

In addition, other global central banks are growing more accommodative. The European Central Bank lowered its deposit facility rate by 25 basis points to 3.25% last week. It left the door open for a similar sized rate cut when it meets again in December. As I mentioned above, the Bank of Canada cut rates by 50 basis points to 3.75% yesterday, while suggesting it could lower borrowing costs even more before the end of this year.

The People’s Bank of China, Sweden’s Riksbank, the Swiss National Bank, the Bank of Thailand, and the Philippine central bank have all taken similar steps. And Bank of England Governor Andrew Bailey has stated it could be more aggressive in lowering rates. These actions should boost the global liquidity and economic growth outlooks. That should be a tailwind for risk assets like stocks.

Currently, the S&P 500 trades at a 21.9 times multiple of its forward 12-month earnings. That’s above the five- and 10-year averages of 19.5 times and 18 times, respectively. Given the outlook for easing monetary policy and consensus expectations for S&P 500 earnings to grow 4.1% and 14.2% in the third- and fourth-quarters of 2024, respectively, stocks should have more room to the upside. The bottom-up price target for the S&P 500 is 6,280, or a rally of 7.3%, over the next 12 months. U.S. Treasury bonds should also rally given the prospect of lower interest rates.

However, the near-term environment is likely to still be choppy. The November presidential election outcome is still uncertain due to a close race. At the same time, stock buybacks are on hold until earnings are out of the way. The combination will keep investors cautious, and stocks could remain under pressure, until the direction looks more definite. But, once these headwinds are behind us (early November), the outlook for stocks should improve, heading into the end of the year.

Investors have questions about the domestic economic growth and valuation outlooks…

The pessimist argument against investing focuses on recent employment data and the stock market’s valuation. Stronger-than-expected September payroll growth has the naysayers pointing to an inability for the Fed to lower interest rates. Sustained strong employment growth would boost the economy. On the valuation front, the S&P 500’s price-to-earnings multiple of 21.9 times forward 12-month estimates, has the bears saying there’s little room for any disappointment in third-quarter earnings results. Disappointing guidance from Dutch semi cap-equipment company ASML Holding (AMSL), and the consequent 26% drop in its shares, has lent support to the valuation argument.

The optimists argue economic numbers suggest growth isn’t as bad as feared. S&P Global’s composite PMI data for September and the New York Fed’s Empire Manufacturing Survey pointed to the potential for a soft economic landing. Retail sales figures for September unexpectedly rose, industrial production rebounded into expansion territory, while housing starts and building permits were stronger than anticipated. Those results suggest consumers are becoming increasingly optimistic about the potential for even lower interest rates and the ability of the central bank to engineer a soft economic landing.

All of that should support more interest rate cuts from the Fed moving forward. The shift will stabilize domestic economic output. Stagflation fears may be overblown given the Atlanta Fed is forecasting third-quarter GDP growth of 3.4% and the Cleveland Fed foresees September headline PCE growth of 2%.

Looking ahead…

The Bank of England could lower interest rates by another 25 basis points when it meets again on November 7. The country’s consumer price index growth slowed to 1.7% in September compared to 2.2% growth in August, making the case for less restrictive policy.

Third quarter earnings reports are now in full swing and wrap up when Disney (DIS) details numbers on November 7. The most important weeks to watch will be at the end of October. That’s when major technology companies like Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), Meta (META), and Microsoft (MSFT) are scheduled to report. Once those results are out of the way, most corporate buybacks can resume, powering stocks higher into year end.

Don’t forget about the under-the-surface positioning shifts taking place. Coming into the September Fed meeting, quantitatively driven fund managers were maximum long fixed income investments while lacking exposure to stocks. The policy decision was a catalyst for unwinding a crowded position in long U.S. Treasurys and dollar short.

Those dynamics support quants selling bonds and buying the dollar, which is driving rates up near term. Those same money managers are slowly rotating back into equities, which will also support a stock-market rally. Once the bulk of the asset swap is out of the way, Treasury yields are likely to back off once more, removing a headwind.

Pre-Market Levels:

Economic Calendar:

Earnings – AAL, HOG, LUV, TAL, UPS (before the open)

Annual Meetings of the International Monetary Fund and World Bank Groups South Korea – GDP (Preliminary) for 3Q Japan – au Jibun Bank Japan Manufacturing, Services, Composite PMI (Preliminary) for October Eurozone – HCOB Eurozone Manufacturing, Services, Composite PMI (Preliminary) for October (4 a.m.) U.K. – S&P Global U.K. Manufacturing, Services, Composite PMI (Preliminary) for October (4 a.m.) Initial Jobless Claims (8:30 a.m.) Continuing Claims (8:30 a.m.) Chicago Fed National Activity Index for October (8:30 a.m.) BOE’s Woods (Deputy Governor) Speaks (9a.m.) BOE’s Breeden (Deputy Governor) Speaks (9 a.m.) S&P Global U.S. Manufacturing, Services, Composite PMI (Preliminary) for October (9:45 a.m.) New Home Sales for September (10 a.m.) Energy Information Administration Weekly Petroleum Inventories (10:30 a.m.) Kansas City Fed Manufacturing Index for October (11 am.) Treasury Auctions $24 Billion in 5-Year TIPS (1 p.m.) Fed's Balance Sheet Update?(4:30 p.m.)

Earnings – COF, VALE, WDC (after the close)

Stories to Know…

Economic Growth:

Domestic…

The U.S. budget deficit grew to $1.833 trillion for fiscal 2024, the highest outside of the COVID era – Reuters. Consumer spending held up in September, underscoring a resilient economy – CNBC. U.S. inflation last month reached its lowest point since February 2021 – CBS News. U.S. job growth accelerated in September and the unemployment rate slipped to 4.1% from August's 4.2% - Reuters. The Institute for Supply Management said U.S. manufacturing activity contracted for the sixth straight month in September – MarketWatch. U.S. job openings fall to the lowest level since January 2021 – Bloomberg. U.S. consumers remain resilient with solid spending in the third quarter, say two of the country's biggest lenders – Reuters. The Federal Reserve’s Beige Book survey showed economic growth is flat to declining in three-quarters of the regional districts – Federal Reserve. Housing costs, the biggest contributor to U.S. inflation, are on track to ease through the end of the year – Bloomberg.

Global…

China's economy grew at a slightly-quicker-than-expected 4.6% pace in the third quarter – Reuters. IMF Managing Director Kristalina Georgieva warned of an “unforgiving” economic backdrop for government finances around the world – FT. Japan's core inflation slowed in September due to the rollout of energy subsidies – Reuters. China’s finance officials said they had a “fairly large” amount of room to boost spending – WSJ. China’s consumer inflation rate fell in September, while producer price deflation deepened – CNBC. Japanese Prime Minister Shigeru Ishiba formally instructed his cabinet to compile a fresh economic package– Reuters. China's home sales rose during the National Day holiday – Reuters. Eurozone inflation growth slowed to 1.8% in September – Bloomberg. Japan's government said it remains cautious about the pace of economic recovery – Reuters. Japan's economy grew at a slower pace than initially reported in the second quarter – yahoo!finance. European banks are on course to record zero growth in mortgage lending for the first time in a decade – FT.

Monetary Policy:

Domestic…

Federal Reserve Bank of San Francisco President Mary Daly said the federal funds rate should return to a neutral level of 3% - Reuters. Federal Reserve Bank of Dallas President Lorie Logan believes it will be appropriate to keep lowering interest rates until they are back to neutral – Dallas Fed. Kansas City Fed President Jeffrey Schmid said he’s not in favor of additional outsized rate cuts – Kansas City Fed. Federal Reserve Board Member Christopher Waller believes policymakers can afford to cut interest rates gradually – Federal Reserve. Dallas Fed President Lorie Logan said interest rates are headed lower not higher - Reuters. San Francisco Fed President Mary Daly said she would support another one to two rate cuts before the end of this year – Reuters. Federal Reserve Vice Chair Philip Jefferson said the September rate cut was aimed at keeping the labor market strong even as inflation continues to ease – Reuters. New York Fed President John Williams said the central bank was now “well positioned” to pull off a soft landing – FT. Atlanta Fed President Raphael Bostic said the labor market remains strong even though it may be slowing – Reuters. Chicago Federal Reserve President Austan Goolsbee said labor market data would support lowering interest rates "a lot" over the next 12 to 18 months – Bloomberg. Richmond Fed President Thomas Barkin anticipates another 50 basis points of rate cuts by the end of the year – Richmond Fed. Federal Reserve Chairman Jerome said policymakers are increasingly confident inflation will come back to the 2% target – Federal Reserve. Atlanta Fed President Raphael Bostic said he’d be open to another 50 basis point rate cut in November if the job market weakens – Reuters. Minneapolis Fed President Neel Kashkari endorsed two more rate cuts this year – CNBC. Federal Reserve Chair Jerome Powell said policymakers are committed to sustaining a low unemployment rate – Reuters. The Fed has significantly improved the odds of a soft landing – WSJ.

Global…

The Bank of Canada reduced its key benchmark rate by 50 basis points to 3.75%, saying the country has returned to an era of low inflation – Reuters. Top officials at the European Central Bank said they may accelerate the pace of rate cuts?in coming meetings –?WSJ. The European Central Bank is keeping its options fully open at upcoming policy meetings – Reuters. New Zealand’s central bank cut interest rates by an outsized half a percentage point - WSJ. European Central Bank President Christine Lagarde left the door open to cut rates in October – ECB. The European Central Bank has a "clear-cut" case for cutting interest rates in October – Reuters. China's central bank said it would tell banks to lower mortgage rates for existing home loans before October 31 – Reuters. Chinese Premier Li Qiang said policymakers will study new incremental economic policies in a “timely manner” – Bloomberg. China's central bank unveiled its biggest stimulus since the pandemic – Reuters. Incoming Japanese Prime Minister Shigeru Ishiba said the Bank of Japan’s monetary policy must remain accommodative – Nikkei Asia. Bank of Japan’s policymakers voiced concern about the need for near-term rate hikes – BOJ. Bank of Japan Governor Kazuo Ueda said the central bank is in no rush to raise interest rates – Bloomberg. Bank of Japan Board Member Naoki Tamura called for interest rates to rise to 1% by late next year – Reuters. Some Bank of Canada officials are worried about the downside risks of inflation – Bloomberg. Bank of Canada Governor Tiff Macklem said it’s reasonable to expect more rate cuts – Reuters.